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Macroscope | As the US fights inflation with a stronger dollar, what about the rest of the world?
- The Federal Reserve’s moves have triggered massive capital outflows from China and pushed the yen to multi-decade lows
- Keeping the dollar strong to fight inflation – in effect a kind of currency manipulation – can be pushed only so far before it triggers extreme volatility and a race to the bottom among export-oriented nations
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The world may not be experiencing full-blown currency wars yet but there is growing turmoil in the currency markets as capital rushes out of China, other emerging markets and Japan into the dollar. Ironically, the only other currency showing strength is the Russian rouble.
It is a reminder that a global monetary order run by and principally for the benefit of the United States cannot serve the world economy’s best interests. The world needs a global monetary authority but it may require a galvanising crisis before this happens.
The US Federal Reserve’s monetary priorities are primarily domestic – fighting inflation, raising interest rates and fostering a strong dollar being the most important now. But Fed policies have a global impact because of the dollar’s key international role in an age of free capital flows.
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The Fed arguably left it too long to begin its fight against inflation before reacting quite sharply, leaving the world to bear the consequences, which are only just beginning to unfold. These promise to be as profound as they are widespread.
China is a good example. It suffered its largest quarterly capital outflow on record in the first three months of this year as foreign investors sold equities and bonds, with local currency bonds accounting for most of the outflow.
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This was due partly to the seductive attractions of a strong dollar as interest rate differentials favouring it grew, even as Covid-19 lockdowns and the “perceived risk of investing in countries whose relationships with the West are complicated” provoke outflows from China, according to the Institute of International Finance.
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